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Is Caterpillar Setting Up for a Cyclical Upswing?
Stock Analysis & Ideas

Is Caterpillar Setting Up for a Cyclical Upswing?

Shares of construction-equipment maker Caterpillar (CAT) received a big lift on Wednesday following an intriguing upgrade from Bernstein analyst Chad Dillard, who raised his price target on the name by $40 to $240. Bernstein outlined “easing” Chinese monetary policy, a continuation of the machinery cycle, and depressed steel prices as some of the primary drivers behind the significant upgrade.

Indeed, there is light at the end of the tunnel as the firm continues managing through supply chain problems. Undoubtedly, COVID-induced supply chain hiccups have been common for many manufacturers, especially those in the discretionary corner of the market.

While Omicron could continue to weigh on the supply chains of many firms, there are reasons to think that things can ease going into the middle of 2022, a time when the cyclical upswing can continue where it left off before the latest waves of COVID.

Bernstein’s upgrade moved CAT stock nearly 2% higher on a big up day for the broader markets. Even after such a solid single-day move, Caterpillar is still a country mile away from its previous highs. With the odds of a cyclical downturn in machinery likely overblown, CAT stock appears like one of few value plays hidden in plain sight on the S&P 500 following its brief move into bear market territory.

As the stock looks to form some sort of bottom, likely on the back of catalysts coming out of China, I remain bullish on CAT stock while the dividend yield remains above the 2% mark.

Too Many Potential Catalysts; Too Depressed a Valuation

When investors turn against a cyclical stock like Caterpillar, extreme downside levels are to be expected. At certain times, the market has it completely wrong, though, and a steep “correction to the upside” may be in order.

If Omicron brings forth another year like 2021, Caterpillar could easily continue lagging the broader markets. Still, the likeliest scenario sees the company make up for lost time as its incredible management team continues navigating through operational challenges that aren’t unique to Caterpillar.

Despite recent woes, the company looks ready to move forward, regardless of which direction the wind blows in the new year. The company’s rock-solid balance sheet and expectations for improving margins are reasons to take a contrarian position in a battered stock that represents value in an otherwise frothy stock market.

At writing, CAT stock trades at just 2.3 times sales and 14.8 times trailing EV / EBITDA. With a relatively low bar set ahead of the company’s Q4 earnings, the company may have the means to sustain a rally towards Bernstein’s $240 price target in the new year.

Management already noted that fourth-quarter operating margins will fall short on a quarter-over-quarter basis, although sales are expected to continue being robust. Although demand out of China has been modest of late, easing monetary policy in China could bode well for spending on big-ticket fixed assets.

Indeed, cyclicality with such highly-discretionary goods can work both ways, and right now, many analysts seem to think CAT stock is oversold ahead of potential catalysts.

Caterpillar’s Autonomy Team Could Yield a Game-Changing Lineup in the Future

As Caterpillar moves through headwinds, huge tailwinds lie on the other side, both in China and the U.S. market. With the financial flexibility to continue pulling the trigger on intriguing firms to improve Caterpillar’s autonomous tech capabilities, the company may be able to innovate its way out of the next structured cyclical decline, or at the very least, dampen the impact.

For now, Caterpillar’s autonomy team seems many years away from launching something genuinely game-changing. Still, it will be tough to keep the stock down when the time comes, as it looks to push for more of a tech multiple and ditch the discount that tends to accompany cyclical stocks.

Wall Street’s Take

Turning to Wall Street, Caterpillar has a Moderate Buy consensus rating, based on eight Buys, three Holds, and one Sell assigned in the past three months. The average Caterpillar price target of $232.67 implies 12.8% upside potential.

Analyst price targets range from a low of $164.00 per share to a high of $290.00 per share.

The Bottom Line on CAT Stock

I think analysts are right to pound the table on CAT stock on its latest dip. While many things can go wrong with a company that’s so economically sensitive, many forget that there are also a lot of things that could go right.

The latest pullback in Caterpillar seems unwarranted and primarily due to fears that Omicron or other COVID variants could cause a repeat of 2021. In 2022, the tides could turn, but should headwinds persist, investors are in good hands with Caterpillar’s managers.

Disclosure: Joey Frenette owned shares of Caterpillar at the time of publication.

Disclaimer: The information contained in this article represents the views and opinion of the writer only, and not the views or opinion of TipRanks or its affiliates  Read full disclaimer >

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